Scanning the news reports about SunTrust
Banks (NYSE:STI) possibly being acquired, this after the bank sold a chunk of
its almost century-old stake in Coca-Cola (NASDAQ:COKE)
to quiet Buy Side critics, we are struck by the terms of the discussion.
Is it not remarkable that the references made by the media to STI's financial performance usually focus solely on earnings growth -- or a
In today's marketplace, where short-term speculative gains seemingly are the sole
concern, the fact that STI for years has performed below peer in most respects seems
unworthy of mention. Yet despite this poor performance history, the market hype of
a possible M&A; transaction has been enough to push the market value of
STI up sharply.
As of Friday's close, the MVE for STI was up
more than 30% from year ago levels. At just over a 15 P/E, a mere 1.8x
book, STI must still be reckoned a bargain -- right? Because STI's
intangible assets now equal 5% of the total, the valuation is a bit richer than
the nominal financials suggest.
In terms of ROA and ROE, for example,
STI has been at or below peer for years, even during the high-tide of the mortgage
market bubble. With an ROA of 1.1% and ROE of 11% for all of
2006, STI is well into the bottom half of the peer group. But the question
remains: Is STI good value at these levels? An examination of the bank's key
credit performance and business metrics suggests not.
STI's loss given default or LGD was 61% for 2006 and has
been well below peer for the past several years, this after peaking around 90% in
2002 (along with the rest of the large bank peers), using public bank unit
data from the FDIC and calculations by the IRA Bank Monitor. Likewise, STI's gross defaults
have tracked consistently below peer and came in at
a mere 21bp last year, the lowest level since 2000. Look at STI as well
as its peers and it becomes clear, at least to us, that 2006 probably was the trough in
terms of bank charge offs.
Basel II Credit
PD Rating, Method 1
PD Rating, Method 2
PD: Default Rate, bp
LGD: Loss Given Default, %
M: Wt. Avg. Maturity, yr
EAD: Exposure At Default, %
Source: FDIC/IRA Bank
STI delivering below-peer LGD
and default experience, what's not to like? Well, unlike peers such as Wachovia Bank (NYSE:WB) and US Bancorp (NYSE:USB), STI has not managed to achieve above-peer financial returns with below-peer credit default experience. In terms of both LGD and gross defaults, the larger WB consistently outperforms STI, yet unlike WB has peer group leading ROA and ROE.
of STI's metrics suggest a low-risk
franchise, perhaps part of the reason that the bank's overall financial
results are so pedestrian. Notice, for example, that
STI's Exposure at Default or EAD has consistently trailed that of the large
bank peer group, at least until 2006, when the large bank peers tightened credit
standards and reduced the overall amount of unused commitments. Perhaps
more interesting that the tightening by STI's peers is that fact that STI has
moved not at all in terms of EAD!
Looking at risk-based capital also is illustrative. The Economic Capital
in the IRA Bank Monitor assigns a ratio of EC to Tier One Risk Based Capital ("RBC") of just 0.63:1, with trading and investments the two largest areas of risk, suggesting that STI's asset mix could be more aggressive. Compare the EC to Tier One RBC ratio of WB at 1.5, USB at 0.67 or Wells Fargo (NYSE:WFC) at only 0.5, yet both deliver far better overall financial results than STI.
STI sports a weighted average maturity or WAM of 5 years, half a standard deviation above peer. With a gross loan yield of 630bp, which has been consistently below peer for years, the picture suggests that STI's loan operation needs serious attention if the bank is to improve its overall financial performance.
Bottom line: STI seems to evidence below-peer credit risk indicators, but above-peer business model risk. With securitization fees as a percentage of income now in single digits, this from 15% in 2002, and loan loss provisions moving back into line with defaults after peaking at a 2:1 ratio of defaults to provisions in 2004, we don't look for upside surprises in the near term.
At $90 per share,
we could see how someone might argue that STI is attractive, but based on the
regulatory disclosure we could also see how this particular institution could
become problematic for the next several years because of chronically below peer
asset returns and rising credit risk experience. If the credit
market bear view of 2008 is correct, what do you suppose STI's and large bank
LGD will look like next year?
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